How close is the Chinese bubble to bursting?

Official's remarks could be attempt at venting; pinning hopes on Beijing 2008

By

JohnShinal

SAN FRANCISCO (MarketWatch) -- In the summer of 2000, the mania for U.S. tech stocks was all the news in financial journalism.

There was a story on the front page of The Wall Street Journal about a group of little old ladies in the Midwest who soured on their boring portfolio as they watched dot-com investors get rich. The good ladies had traded their utilities for the shares of technology firms.

That was during the interlude between the bubble's first leak in March, 2000, and the loud pop some nine months later.

We know how that movie ended, with two big sevens. Total stock market worth shrunk by about $7 trillion before the subsequent bear market was over. Almost seven years after the top, the Nasdaq Composite Index is worth about half what it was then. Now: pushing 2,500. Then, topping at 5,000.

The sequel is starring homeowners in Shanghai, who are taking out second mortgages to buy stocks of fast-growing Chinese firms, as The Journal reported this week.

Are they right, these retail investors with little experience in public stock markets? Can Chinese stocks still be a buy after spectacular gains over the last year?

You may want to ask Cheng Siwei, the Chinese official who took a little air out of the current bubble with comments that the stock market there may be overheating. Cheng used the 'B' word this week and the Shanghai Composite index, which had gained a whopping 130% in a year, lost nearly 5% in a day. See full story.

MarketWatch quoted the same word six months ago when we reported that venture capitalists like Lip-Bu Tan of Walden International and other veteran China investors were leery of valuations driven higher by speculative buyers flush with cash. See full story.

That story followed a report by Fitch Ratings that documented how aggressive lending by Chinese banks and heavy government spending in advance of the 2008 Beijing Olympics have inflated a liquidity bubble. Around the same time, government officials urged Chinese banks to tighten lending practices after the money supply surged.

Since then, foreign investors have poured another $100 billion and more into China, which is flush with its own cash as its economy grows 10% a year and its real estate and stock markets generate huge equity returns.

Those are all the ingredients needed for a classic bubble recipe, which is, at the very least, simmering.

Mixed Net sector could be canary in the coal mine

As with the U.S. stock bubble, the Chinese bubble has been led by Internet stocks.

Baidu.com Inc.,
BIDU, +1.33%
the Chinese search engine company that is growing faster than Google, and online travel firm Ctrip International
CTRP, +1.37%
have been standouts, both rising about 125% in the last 12 months.

Other Chinese Net Stocks are up big during the same time, with portal Sina Corp.
SINA, +0.35%
up about 50% and Sohu.com Inc.
SOHU, +2.69%
about 25% higher.

But other Internet stocks haven't fared as well.

Kongzhong Corp.
KONG
and Tom Online Inc.
TOMO
two providers of wireless Internet services, including gaming, are both down close to 40% during the past year. Both were hurt by government-mandated restrictions on certain messaging services such as personal horoscopes, which had been a big driver of Internet traffic.

One-time high-flyer 51Job.com Inc.
JOBS, +0.44%
has been flat during the same time that the Shanghai Composite, as noted above, more than doubled, and giant telecom service providers like China Mobile and China Unicom are up 90% and 55%, respectively.

In other words, some of the boats in the Internet sector which had been rising together on the tide of Chinese liquidity have now sprung some leaks, with stocks whose one-year returns badly lag the broader market.

A similar dynamic took place in 2000, when the telecom bubble outlasted the dotcom bubble by less than a year.

Chairman Greenspan, meet Chairman Mao's successors.

Officials like Cheng, vice-chairman of the standing committee of the National People's Congress, can have the kind of short-term sway over financial markets that in the U.S. is reserved for a rare few former Federal Reserve Chairman Alan Greenspan, for example.

Considering that Cheng lopped 5% off one of the country's most important indexes in a day, it would behoove retail investors who own China ADRs to stay abreast of such remarks.

Meanwhile, investors either brave or stupid enough to try to time the top of the Chinese market in tech stocks may want to attempt to divine whether indexes there look more like they did here in 1996 or in 2000?

Asked another way, was the official comment that spooked China investors this week comparable to Greenspan's warning of "irrational exuberance" in U.S. markets, or a more urgent warning like the alarms sounding from little old ladies' investment clubs in the summer of 2000.

Last July, Walden's Lip-Bu Tan predicted that China would see a stock market collapse similar to what happened here "within three years."

Other investors told me then that they were fairly confident that the Chinese government would find a way to keep the liquidity bubble afloat at least until the Beijing summer Olympics. Perhaps Cheng's comments this week were an attempt to ease some of the pressure that always precedes a pop.

Either way, the clock is ticking.

If you're an investor who's currently holding handsome profits in Chinese ADRs, ask yourself when you plan to sell -- when you're up, or when you're not.

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